Fed to launch fresh bond buying to help economy

By Alister Bull

Published December 05, 2012

Reuters

WASHINGTON – The Federal Reserve is set to announce a fresh round of Treasury bond purchases when it meets next week, avoiding monetary policy tightening to maintain support for the weak U.S. economy amid uncertainty over the looming year-end "fiscal cliff."

Many economists think the U.S. central bank will announce monthly bond purchases of $45 billion after its policy gathering on December 11-12, signaling it will continue to pump money into the U.S. economy during 2013 in a bid to bring down unemployment.

"We expect status quo," said Laurence Meyer of the forecasting firm Macroeconomic Advisers. "We expect purchases will continue at the same monthly rate as over the last three months; that the composition will be the same, and that the maturities distribution will be the same."

The decision would cement expectations that the Fed will keep buying a combined $85 billion of Treasuries and mortgage-backed bonds a month, while repeating that it expects to hold interest rates near zero until at least mid-2015.

The Fed could even decide to announce a larger level of purchases if it wanted to exceed expectations and give the market a bigger jolt to press borrowing costs lower.

"If the market expects $45 billion, maybe they should deliver $60 billion ... get markets more excited and really push rates down," said Torsten Slok with Deutsche Bank in New York.

U.S. unemployment remains high at 7.9 percent and the economy, while doing better than Europe's, is expected to grow at a meager rate of only around 2 percent next year.

OPERATION TWIST

The fresh bond purchases will replace a program called Operation Twist, which expires at the end of the year. Under Twist, the Fed bought $45 billion of longer-dated bonds a month with the proceeds from the sale of its shorter-date holdings.

Fresh outright purchases would therefore create new money, whereas no new action by the Fed would amount to a tightening in monetary policy as Twist came to an end.

Add in monthly $40 billion mortgage-backed bond purchases which it began in September, this would boost the Fed's balance sheet by $1.2 trillion, to $4 trillion, by end-2013 if it keeps buying assets at this pace, as economists expect.

"I think it is going to be (maintained) into 2014 because they are not looking for much improvement in the unemployment rate over 2013," said Stephen Oliner, a resident scholar at the American Enterprise Institute.

The Fed has promised to maintain its efforts to stimulate growth until it sees a substantial improvement in the outlook for the U.S. labor market.

THRESHOLDS

However, it has not spelled out exactly what that means and is not likely to use next week's meeting to act on an idea advanced by some senior Fed officials to adopt numerical thresholds for unemployment and inflation to guide policy.

These have been floated as a better way to give markets and the public so-called forward guidance on when the Fed will start raising rates, rather than its current calendar date commitment.

The idea is to create a tolerance zone within which the Fed would leave rates on hold. But economists think it would prefer not to risk confusing markets by making too many big announcements when it releases its policy decision on Wednesday, expected at 12:30 p.m. ET. The statement will be followed by a news conference with Fed Chairman Ben Bernanke.

Analysts also doubt policymakers have had enough time to reach a consensus on measures that amount to a major step forward for the central bank's communication strategy that would influence Fed policy for years to come.

"At this point, I'd be a little surprised if they had actually managed to reach agreement about what the quantitative thresholds should be," said David Stockton, senior fellow at the Peterson Institute for International Economics in Washington.

Both Bernanke and Vice Chair Janet Yellen have indicated support for the idea, which has been advanced by several of their colleagues.

But analysts felt it made more sense to take the step in the early part of next year and concentrate on explaining the decision to increase asset purchases at the news conference next week.

Policymakers must also update quarterly economic forecasts despite uncertainty over how much of a drag fiscal policy will exert on growth as Congress and the Obama administration fight over taxes and spending designed to lower the U.S. deficit.

Failure to agree on a deal could tip the economy over a so-called fiscal cliff of tax hikes and automatic spending cuts, which many fear could trigger another U.S. recession, and which the Fed has repeatedly said it would not be able to offset.

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